My Other Accounts

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Securities and Exchange Commission

August 22, 2011

The Concept Release on auditor independence and mandatory rotation, issued by the Public Company Accounting Oversight Board on August 16, sought comments. Believing that those who presume to offer commentary should include potential solutions along with their griping, I put forward these thoughts:

There is a way that rotation could be tried and tested without the cost, disruption and doubtful achievability of a wide-scale requirement – problems that leave me and most others so skeptical.

Which is that in a specific case, if the PCAOB can sustain its proof that long audit tenure was causally related to its definition of “audit failure,” it could include rotation in its toolkit of post-inspection sanctions.

Since the PCAOB looks annually at a sampling of engagements for each of the large audit firms, and claims to target its inspections on the basis of perceived engagement risk and exposure, the agency’s experience base should bring to light cases – if any – where audit quality might be affected by length of tenure.

In which case, rotation could be proposed, and if necessary, imposed.

The sanction would not be an enforcement reach, if a credible case were made – the agency could act on its own statutory authority or in coordination with the powers of the SEC. (See the SEC’s imposition of a government-appointed monitor on KPMG as part of the 2005 resolution of the criminal investigation of its tax-shelter practice, or the six-month bar on new SEC clients imposed on Ernst & Young in 2004 for its impaired independence arising out of business relationships with its audit client PeopleSoft.)

Due process and negotiations would sort out the appropriate cases to require rotation. Many cases of financial statement failure – contrasted with the Concept Release’s definition of “audit failure” as involving alleged deficiencies in audit work alone – result in termination of the auditor/client engagement in any event, and would fall out. Other inspection cases would involve causal facts unrelated to tenure – such as personnel competence or supervision – making rotation a doubtful remedy. And since real sanctions would presumably only be applied in a publicly transparent environment, the PCAOB would achieve the disclosure it professes to desire (here) -- along with the obligation to establish the credibility of its findings.

Rotation if proposed as a sanction would allow the incumbent auditor to be heard and argue its case – or perhaps even to settle with an agreement to stand down. It would also open the record to possible resistance by a non-US regulator, in the especially challenging cross-border cases involving global companies (here) – as well as to the fact-based airing of issues of impracticality or constrained choices of successors.

(By the way, a free-market evaluation of possible limits on alternative auditor choice could be made through the sanction of mandatory re-tender -- as opposed to the perhaps harsher remedy of outright rotation.)

The principle of “first, do no harm” was cited by PCAOB member Lewis Ferguson in his statement on the Concept Release. Case-by-case use of rotation as a sanction would satisfy the corollary: anticipate unintended consequences whenever possible, and do minimal harm in any event.

Selective required rotation would also address an emerging issue in the effectiveness of policy choices – a topic treated in my MBA-level course in Risk Management.

Namely, examples are increasingly discovered that where instances of non-compliance are serious – but rare and tightly clustered -- the deployment of a broad, sweeping enforcement program is likely to be both wasteful of scarce resources and ineffectual in achieving the desired goal.

Three examples:

With the progress in control of automobile exhaust emissions, it is massively wasteful in administrative costs and car-owner time to require on-site tests for late model cars. The miniscule percentage of vehicles that generate most of the pollution can instead be detected by inexpensive, portable drive-by testing, with immediate ticketing and impoundment.

The billions in costs and inconvenience inflicted on airline passengers by security programs, accomplishing only inconvenience and embarrassing privacy intrusions, have negligible anti-terrorist effect, compared with the highly sophisticated results of effective data-tracking and suspect profiling.

And among the population of urban homeless, the great bulk of the cost of scarce resources for shelter, law enforcement and emergency medical care is consumed by a tiny fraction – who are more effectively addressed through individual identification and tailored attention.

Mandated rotation in those rare cases where tenure length might demonstrably be an issue presents a similar environment. Audit failures being real, but also rare, across the entire time-line of auditor tenure, there has not even been a proper study, much less a showing, that length of tenure is a causal factor.

So enforcement sanctions, including rotation, should be conserved and only deployed accordingly.

To summarize: individualized mandatory auditor/client rotation could be used as an appropriate case-by-case sanction – if but only if the PCAOB can persuasively show a basis.

Or as Messrs. Gilbert & Sullivan’s Mikado nearly put it in 1885:

“An object all sublime

“They shall achieve in time --

“To let the punishment fit the crime.”

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May 09, 2011

There are at least two positive reasons for attention to the New York speech delivered on May 5 by the PCAOB’s newbie chairman James Doty – here.

Although no rhetorical threat to the real wordsmiths of the Beltway, Doty has the ability to turn an adult phrase -- finally re-writing the agency’s longstanding pattern of turgid language and opaque vision.

As can be seen, first, in his readiness to reject the “structural alternatives such as a third-party payor or insurance-based system,” or to see the trial balloons floated in the UK or in Brussels to break up the Big Four – properly “the bailiwick of competition authorities” – as having a “negative effect on audit quality.”

Modest applause – these diversionary detours being long since exposed as dead ends (see here and here).

Second, Doty offers relief at last – although perhaps inadvertently -- from the otherwise reluctant but compelling conclusion that since passage of the Sarbanes-Oxley law in 2002, the PCAOB has managed to pass from immature ineffectiveness directly to self-perpetuating inertia without ever achieving a record of real accomplishment.

Namely, a healthy admission of the agency's inward focus is at least implicit in Doty’s acknowledgement that auditor oversight and quality enforcement are shrouded in PCAOB confidentiality and concealed from public transparency and deterrent impact. The same inference is recognizable in Doty’s reference to recently commenced “joint inspections with U.K. and Swiss authorities” – surely two of the lowest-hanging fruits dangling from the limbs of cross-border enforcement – only showing the glacial pace of progress over nine years.

Meanwhile for candor and completeness, his concession of an inability “to inspect a registered firm’s work” in context of the “growth in the number and size of Chinese companies seeking access to capital in U.S. securities markets” requires acknowledgement of this year’s outbreak of litigation claims against Chinese issuers – catalogued by the ever-informative Kevin LaCroix’s D&O Diary, and the risk-based subtext of the PCAOB’s own March-dated research note.

Credit as due for these positions, but the Chairman ventures onto even riskier ground.

To start, his cheerleading that the auditors’ “lofty status” as “guardian of a cultural value” is akin in importance to electricity or water, presumes to invoke the name and record of the late chief accountant of the SEC. But the legacy of Sandy Burton’s 1980’s advocacy for greater auditor responsibility only highlights the absence of substantive change over the span of an entire generation.

Likewise, Doty’s critique of the payment model by which “the auditor is hired and paid by the company itself” is devoid of vision for change in a structure embraced since the emergence of independent assurance to assist shareholders in the Victorian era of the 1850’s.

The market's vote for persistence of “client pays” does not fault the limited influence of audit committees on economic relationships having 150 years of history, pace Doty’s slap at their lack of impact. The durability of that model and the absence of viable alternatives only expose, instead, the intellectual fragility of the entire cosmetic attempt to regulate “appearances of independence” and the richly-deserving consignment of that sacred cow to a decent burial (as I have written for years – see here and here).

Rather, it is the narrow and anachronistic language of the current compliance-oriented audit report itself – a document having value in today’s environment not by the free choice of issuers or users but only because required by the fraternity of regulators to which Doty himself belongs – that operates as a shackle on innovation.

Here Doty stands exposed. Correctly recognizing that “auditors don’t have a natural incentive to evolve their reports to what investors want” – a position long argued (e.g., here, here and here) – Doty has put down a major marker: He promises a “concept release” for early summer, to consider “how the auditor’s report can be changed to provide more useful, relevant and timely information.”

Can the Chairman really mean it? And how, without conceding that his own agency (along with the SEC) holds the keys to the lock?

He avows that “there is no silver bullet to address these challenges.”

But in this he is wrong. That bullet today is loaded in the deadly weapon of litigation roulette, which aims existential exposure at the large firms for their issuance of the very reports Doty purports to recognize as failing to deliver value to users.

To disarm that weapon – to create and nourish an environment in which real innovation in assurance and investor value can be brought forth – will require a leader's brave step, up to now unimaginable: scrap as worn-out and useless the obsolete one-page compliance report, along with the devastating machinery of liability that has grown to encage it, and start with fresh and creative authorship, written on an entirely blank page.

The first PCAOB chairman left office with the admission that regulators “don’t have a clue”(here). Today's occupant not only has the opportunity to show otherwise. Doty's speech makes hostage to fortune and accountability in office his own readiness to act.

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April 20, 2011

In a late pre-retirement hurrah, outgoing International Accounting Standards Board chairman David Tweedie has made a bequest to his successor: last week’s agreement with Leslie Seidman, his opposite number at the Financial Accounting Standards Board, to extend by “an additional few months” the already elastic June 1 date for completion of the decade-long aspiration to converge international and American accounting standards (transcript here or here).

Is there a sentient being on the planet who is so benighted as to claim surprise?

Long predicted (here), the continued slippage in this always-distinct possibility – hardly deserving to be credibly described as a “target,” much less a “deadline” – continues to recede into the distant future.

Which was inevitable, for two reasons, purely aside from the dubious substantive merits (no better addressed than by Tom Selling’s acerbic Accounting Onion).

First is that the still-unfinished workload of four pending priority projects – the individually challenging topics of leasing, revenue recognition, financial instruments and insurance – had long been recognized as impossible of accomplishment within the resources of the two bodies and the politicized obligations to their antagonistic constituents (here). And that’s even if there had been agreement between the bodies themselves, which on these highly-complex subjects, there is not.

Second and more fundamentally, the tediously-reported proclamation of real convergence commitment has never been more than a smokescreen behind which the divergent interests of the Americans and the Europeans have knocked heads to the point of insensibility. (For which, recall the continued fudging of the SEC as to whether, if ever, that agency is even going to confirm a date certain on which to decide if to weigh in or not (e.g., here and here).)

Why no-one has called the question on this endless charade reflects the two-level fantasy in the dialog: the IASB and the FASB both pretend to believe in the desirability of fully-converged accounting standards, and the community of financial statement issuers and users pretend to believe them.

At the same time, the complexity of standards within either IFRS or US GAAP expands apace. The example is the latest annual report from HSBC, which achieves a stunning 392 pages (here), thereby vying in both bulk and opacity with such legislative monstrosities as the Dodd-Frank law or the EU rules defining chocolate.

There is a striking and pertinent observation, in academic studies of breakdowns and failures in large-scale strategies: once a project starts to go over time and budget, each of the successive series of further delays and over-runs is typically longer and more costly than the last.

Public works projects are notorious: the Sydney opera house was completed in 1973 for A$ 102 million, nine years late and 15 times over its initial A$ 7 million budget. Finally completed four years late in 2003 for $ 14.6 billion, Boston’s “big dig” harbor highway tunnel tripled its initial estimate. The Eurotunnel was a happy contrast, only one year late in 1994 and a mere $ 3.6 billion over budget.

Military and political conflicts are equally instructive. President Bush’s May 1, 2003 speech under the “Mission Accomplished” banner, two months into the conflict in Iraq, is now at eight years and counting. The continuing escalations of American commitment in Vietnam for a victory supposedly just around the corner still have tragic resonance. The broken promises of peace in the land of Abraham’s children date not just to the founding of Israel in 1948 but at least back to the Balfour Declaration of 1917.

In Joseph Heller’s darkly comic 1961 war novel “Catch-22” – still the best manual in print on the absurdities of dysfunctional organizational management (see my January 2004 review in the International Herald Tribune) – the sycophantic lieutenant Scheisskopf secured his reputation and his promotion by the strategy of announcing that the much-despised weekend parades would not be held.

(Anyone missing the scornful locker-room epithet is invited here for his name’s translation from the German.)

Tweedie and Seidman having picked their low-hanging fruit, they now confront the reality of a tree too tall to climb. So the virtue of their other modest accomplishments being acknowledged, their adoption of the Scheisskopf technique of perpetual postponements invites skepticism and ridicule in kind.

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April 06, 2011

“Two aristocrats challenge each other to see which can come up with the larger number. The second agrees to the contest, concentrates for a few minutes, and proudly announces, “Three.” The proposer of the game is quiet for half an hour, then finally shrugs and concedes defeat.”

-- John Allen Paulos, “Innumeracy,” 1988

The PCAOB’s April 5 settlement with the Indian firms of the PwC network, over the billion-dollar fraud at Satyam Computer Services Limited, adds a $1.5 million fine to the six million dollars the auditors also agreed to cough up to the SEC.

(Statements from the agencies are here and here; see Going Concern for the orders; and the NYT for statements from PwC.)

The amount compares to the aggregate salary of the five PCAOB members of $2,366,000. It would be a small fraction of either the annual compensation of PwC’s global chief Dennis Nally, or the firm’s legal fees on Satyam to date. And even measured by the $ 550 million ponied up by Goldman Sachs under its August 2010 SEC settlement of its one-issue dispute over the “Abacus” derivative peddled by its fabulous Fabrice Tourre (here), the amount is derisory.

The Big Four giant is still facing on-going investor claims, to be sure. But the exposure is well-fenced; the Supreme Court’s June 2010 decision in Morrison closed the doors of the American courts to foreign securities claimants who bought their shares abroad, and the inexperienced Indian judicial system lacks the competence to be an attractive plaintiffs’ venue.

Consider the motives from the regulatory perspective. The settlement timing ahead of the April 6 hearing of the Senate Finance Committee on the role of the accounting profession in the financial crisis (here) gave senior officials a public forum. And the media coverage allowed the SEC’s enforcement head Bob Khuzami and FCPA unit chief Cheryl Scarboro, and the PCAOB’s chairman Jim Doty and his enforcement head Claudius Modesti, all to strut their achievement against foreign auditors – even while avoiding the obligation actually to try their case across international borders.

From the PwC perspective, meanwhile, the chance for a cheap exit from a major problem would have been a no-brainer. Consider:

First, an enforcement ding on the Satyam engagements had to be coming, sooner or later. From the PCAOB’s order – which PwC agreed not to contest – the Indian engagement teams on the audits from 2005 through 2008 basically did not:

Adequately audit the company’s cash positions

Control the confirmation process on bank balances or accounts receivable

Pursue indications of inconsistent information or control weaknesses

Follow PwC global directives on audit execution

Inform or advise higher-level quality oversight personnel

Document the work actually done (or not) in the work-papers, until subsequent back-dating while already under regulatory scrutiny

So a strategic decision not to defend the indefensible indicates early recognition of a step toward sustainable credibility.

As for the sanctions – PwC’s undertakings on future practice quality, staffing, training and internal oversight are no more than necessary for an enterprise with aspirations to professionalism; the two-year presence of an outside monitor only adds one more stranger to the list of foreign intruders imposed on its Indian practice; and the six-month restraint on new SEC clients runs only to the settling Indian firms, so does not inhibit either the global network or its other Indian affiliates.

And, lastly, the financial impact of the fines on the massive PwC network is no more than a dime added to a roll of nickels.

For good measure, with the week’s news cycle dominated by military activities in Libya and a threatened government shut-down in Washington, and subsidiary attention to post-earthquake Japan’s nuclear hazards and Silvio Berlusconi’s “bunga bunga” trial, the entire story will drop off the media screen in less than no time.

Predictably, critics of the accounting profession who are unwilling to settle for less than the scalps of the Big Four leaders nailed to an enforcer’s door will make their outrage known.

But they will fail to acknowledge that both the regulators and PwC itself are only acting in full accordance with their respective DNA.

So once again, this settlement points up the challenge to the long-term achievability of a valuable, sustainable assurance function, to serve the issuers and users of the financial information of global-scale companies: the terms of the discourse are revealed as hopelessly inadequate.

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February 28, 2011

There’s a folk tale’s moral about the aggressive bird, who filches a whole length of sausage from the butcher’s market stall, eats his larcenous fill, and celebrates by singing from the treetops at full voice – only to be spotted and shot for a hunter’s dinner:

When you’re full of bologna, keep your mouth shut!

Or as attributed to Voltaire, with rather more gentility – “better to keep silent and be thought a fool, than speak up and remove all doubt.”

As calendar-year American public companies face their deadlines for annual filings with the Securities and Exchange Commission, there are benefits to a blogger’s ability to keep quiet – a comfort compared with my prior writing life under the regularity of a newspaper deadline – especially in resisting the siren call to publish for the sole sake of reader traffic above all else.

But even for want of a compelling subject, fingers get itchy at the keyboard. Something feels ominous in the world of financial scandal and accountancy distress. It’s just been too quiet out there.

It could simply be impatience with officialdom’s combination of lassitude, inattention and inertia:

Michel Barnier’s EU-level initiative of a green paper consultation on the fragile state of the global audit franchise has come out as the predictably damp non-event (here).

America’s Dodd-Frank legislation addressed not a word to the obsolescence of the entire financial reporting and assurance model.

Regulators have walked on tip-toes around the implications of issues from the degraded state of Citibank’s internal controls (here) to the Bank of England’s body language that enabled clean audit reports on the UK banks (here).[1]

And the re-cycled trio of new members at the PCAOB, with old SEC hand Jim Doty in the chair, has offered only more of the same likely inaction that has characterized the torpor of its first nine years (here).

Not for nothing do major financial scandals emerge around the time of full-year information release. Investors’ expectations are whetted. Ponzi schemes escalate toward their inevitable explosion. And those pesky auditors are poking and prodding in dark and unwelcome corners.

Think back: Parmalat broke in December 2004; the rogue trading at Société Générale came out in January 2008; Bernie Madoff was exposed in December 2008; the CEO’s letter of confession in Satyam was delivered in January 2009; and January 2010 unveiled the looting via Amex card at Koss.

There are ample examples validating the risks concealed in the calm before the storm: the crime-solving deduction by Sherlock Holmes from the dog that didn’t bark, the siege guns’ silence just before the invasion, the receding waters before the tsunami, the movie cliché when the hero’s B-list sidekick whispers in terror that the native drums have suddenly stopped.

The looming sound of silence is not always a signal. Sometimes the other shoe never does fall. An extended period of quiet does not mean that an outbreak must occur. But that is not ground for comfort or complacency either – it’s a flawed and mistaken inference that because the scandal level has been muted, it won’t erupt.

Somewhere out there, instinct cries, fresh new trouble is brewing.

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[1] Those with an appetite for satiric musical comedy are invited to imagine the UK’s House of Lords committee or the commissioners of the SEC as part of this chorus of hapless and ill-equipped pirates in Gilbert & Sullivan’s classic.

December 09, 2010

I try to raise the sense of my students in Risk Management for trends, patterns and common themes – early awareness being an opportunity for effective strategy.

So when the muddied state of auditor-clients relations was twice and separately further obscured in recent days, attention should be paid.

First, a reader sent me a lament overheard at a Thanksgiving table -- a second-year audit staffer at a Big Four firm, who had been trying without success to persuade his 38-year-old supervisor that there was a defect in the results of their engagement performance. The futility of his efforts was leaving him with the dispirited feeling, as he put it, that he had become in effect an employee of the client.

The second, at the AICPA’s Washington conference on SEC and PCAOB developments, was SEC Chief Accountant James Kroeker (here) – advocating “a change to our collective vocabulary…. (D)on’t use the word ‘client’ to refer to the management of companies under audit…. (I)t is time to give serious consideration to changing the perceived ‘client’ in audit relationships.”

The uneasy dilemma of the beleaguered young staffer is no surprise, because among the many pernicious effects of Sarbanes-Oxley has been a three-fold degrading of the auditor/client relationship. From an advisory role to one of adversity and compliance – and so forms-and-process based that young professionals lack the environment in which to learn and absorb actual client business -- under on-going stress on revenues and profitability, the firms’ clear imperative to their staff is to complete the work needed to issue another commodity report, “on time, within budget, and without making waves.”

The dynamic for an eager but career-sensitive young professional is no better put than by my senior-level friend: “When you raise a problem, then by definition you become the problem.” No wonder, then, when “client satisfaction” – the long-popular mantra across the spectrum of commercial activity – readily elides to “client capture.”

While back in Washington, the vagueness of Kroeker’s musings became truly misleading as picked up and re-broadcast under the 140-bit limits of the profession’s twittering critics – mutated to the direct question “who is the client?” as if the auditor’s “primary responsibility was to investors, not the companies they audit.”

Kroeker and his agency are of course entitled to advocate for a nationalized audit function carried out by civil servants. If so, let them say so with candor, and let the debate be engaged – it will be revealed quickly enough how the community of financial information users would compare the value of today’s archaic and obsolete report with an equivalent document delivered by federal agencies distinguished by their inaction during the tumultuous events of the last three years.

Until then, it requires recalling that it has been a basic premise since the 1930’s passage of the American securities laws, when the profession lobbied successfully for private control of the assurance franchise, that the company under audit does the hiring and pays the bills.

Indeed, the disregarded consequences of that plain election in favor of an unambiguous definition of “client” are amply shown in the vast amount of time and energy wasted in the intellectually ineffective attempt to define with precision what constitutes an “appearance of independence,” in light of the contractual and economic linkage of direct auditor engagement.

It is also readily recognized that important rights and obligations arise outside the strict confines of a provider-client relationship. Concepts based in agency, trust and fiduciary duty are familiar – as is legislative authority to create duties based on extra-contractual reliance and expectations, whether for investors, consumers or even innocent by-standers.

But it does no favors to the complex challenges to evolve a valuable and sustainable audit function, to blur the lines of accountability with careless invocation of an ill-defined shift in client identity.

Or as I also try to instill in my MBA students, the guidance is still relevant as laid down by 18th century lexicographer Samuel Johnson, that “sloppy language is a mark of sloppy thinking.”

As the poor staff auditor is learning under career-threatening pressure, the issues facing the role of auditors are already sufficiently profound. From the senior regulators in Washington, they deserve clearer articulation than they now receive.

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September 26, 2010

At least one piece
of the Dodd-Frank legislation now has a ribbon neatly tied around it: the
Securities and Exchange Commission has issued its rules to exempt small
companies – generally those with less than $75 million of common equity – from
having a separate independent auditor’s report on their internal control
assurance under Section 404 of the Sarbanes-Oxley law.

I’ve been quiet on
Dodd-Frank. Why not? Unmanageable in its creation, incomprehensible in its
enactment, unpredictable in its consequences, as it was. Who could work up an
appetite to ingest such a pigs’-breakfast of law-making?

Small companies may
say, with the night watch in Hamlet’s Elsinore, “For this relief much thanks.”
But marginal tinkering with the mis-begotten obligations of Sarbox 404 will
matter less, and for different reasons, than are usually put on view.

To start, the toxic
post-Enron environment in which Sarbanes-Oxley was enacted in 2002 has
effectively immunized its impositions from critical cost-benefit evaluation.
Persistently asking the wrong question – “Has the quality of corporate reporting
actually improved since the days of WorldCom and HealthSouth?” – not only
ignores the built-in cyclicality by which outbursts of scandal are purged by
self-cleansing returns to virtue. It also leaves unasked the proper question: “Is
that reporting better than if Washington had done something else – including
doing nothing at all?”

More importantly,
can any scarred survivor of the last three years of Bear-Lehman-Fannie-Freddie-AIG-Merrill
– the most disruptive economic period since the Great Depression – argue
seriously that auditors’ reports on the “out-of-controls” of those fallen
industry giants actually made any positive
contribution to systemic safety, stability or credibility?

In that dreary
context, of course, it makes perfect rational sense to give small companies a
“Get Out Free” card.

That’s because, as
I was advised about parenting strategy when our daughter was born: “Little
kids, little problems; big kids, big problems.” A new father’s worries escalate, from the essentially trivial inconvenience of an infant’s colic or
spilled oatmeal, on to little league injuries and a teenager’s driving safety,
up to college admission and the launch to the challenges of adulthood.

In the same way,
the fewer zeroes on a balance sheet, the lessened likelihood of systemic impact
of mis-behavior that makes a difference. “Out-of-control” at a Koss or an American
Apparel may be inconvenient for a limited constituency, and provide grist
for the mill of the plaintiffs’ securities class action lawyers – but otherwise
doesn’t matter in the great scheme of things. It’s altogether different when
the entire global financial system can seize up under the effects of a
threatened, undetected and undeterred collapse at an AIG or a Lehman.

History and
experience teach that regulatory systems designed and applied under motives of
political correctness over the fat part of the compliance curve are wasteful
and ineffective – whether aimed at school truancy, auto emissions or corporate
disclosures. Instead they will fail to identify and address the “outliers” that
actually prove disruptive – the SEC’s sorry performance in regard to Bernie Madoff
and Allen
Stanford make the case.

Section 404 reports
on small companies were never any more likely to be effective by way of
detection or deterrence for small companies than they have proved for the
large. So it was an inevitability that inflicting Sarbox 404 auditor reports on
small companies would have been largely an exercise in even further futility.
If regulation has not worked for the big and dangerous, in other words, how can
it be good or useful for the small and irrelevant?

Drab as it may
seem, finding negative comfort that at least our legislators have stumbled into
a way to avoid making a weak situation even worse, there is both logic and
benefit in leaving bad enough alone.

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with friends and colleagues. Comments are welcome, and subscription sign-up is
easy, both at the Main page.

August 11, 2010

Even in the depths
of summer, the settlement agreed last month by Goldman Sachs to resolve the
charges of the US Securities and Exchange Commission relating to “Abacus,” the
toxic subprime mortgage-based derivative, attracted howls of antagonism.

A reader here
called it “total joke” and “a blatant PR splash by the SEC.” Among the
bloggers, plaintiffs’ lawyer Jake Zamansky addressed his constituency in high
dudgeon, about “letting Goldman off the hook” for “a measly $ 550 million
without admitting any wrongdoing”(here). Andrew Ross Sorkin in the New York Times focused on
Citigroup’s own $ 75 million SEC settlement (here), but included Goldman’s deal in pointing out that corporate
fines come ultimately out of the pockets of shareholders of the offender, not
the responsible senior executives.

There’s certainly no
need to plead for Goldman. It deftly submitted to an early-stage punishment it
could readily afford to bear, from a government agency apparently lacking the
stomach for a protracted battle and therefore signaling significant anxiety
about its case on the merits.

There are limited
options for punishing a corporation – money fines, behavioral monitoring, or
the ultimate loss of its right to exist. As only the abstract, legislatively
chartered sum of its corporeal parts – directors, managers, employees,
shareholders and customers – a corporation is an existential construct that
cannot be imprisoned, flogged or otherwise subjected to more personal
sanctions.

So for starters, no
responsible authority has suggested that the financial sector either in the US
or globally would be better off if Goldman had been punished to the point of
extinction.

Instead, times have
changed. Arthur Andersen disintegrated in 2002 under the Justice Department’s
Enron-related indictment – the avoidable and unnecessary result of a series of
tragic-comic tactical blunders on both sides. Since then, federal prosecutors
in America have treated the financial services sector with the delicacy of
Oscar Wilde’s maxim that “a gentleman never hurts anyone’s feelings –
unintentionally.”

Consider by contrast
the future fate of Fabrice Tourre – the Goldman wheelman on the Abacus deal,
who having missed the settlement bus, is now left for road kill.

Did he seek to
participate along with the company’s settlement, only to be left as the sole
remaining defendant? My calls to his lawyer elicited no response. And the SEC
itself never comments on pending litigation. But as reported on August 9, the
SEC staff did disclose to the federal court in New York that “very preliminary”
settlement talks with Tourre had occurred (here).

It would be
inverted logic for the agency to claim a notch on its battle-axe for the $550
million result against the company, yet to view Tourre as such a significant
player that it would refuse to negotiate with him. He is simply too small a minnow
in the Goldman pool, compared to the big fish the SEC did not even charge,
starting with chief executive Lloyd Blankfein and president Gary Cohen

.

On the other hand,
if Tourre was at the settlement party but could not find the exit under
virtually any penalty that left him at liberty, either he or his counsel
deserves a whack. Tourre faces a long haul of pre-trial depositions and
document production, costly in both funds and emotion. Even with Goldman
footing the financial bill, the grind on an individual opposing the forces of
government is eventually crushing to the spirit.

Callow and
over-stated enthusiasm for his defense position would be no great surprise, but
a defendant’s stubborn pride that he was an innocent under venal superiors is a
commodity whose value depreciates with the extended duration of a prosecution.

That is, Tourre is
a dead man in the industry no matter what. There is now a record against him
that includes Goldman’s concession of “mistakes” – although not liability or
culpability. Tourre will therefore lose his motions for early extinction of the
charges.

So any later
settlement window will only open just before a trial, when the SEC will have
its engines humming and when an outcome must be worse than anything Tourre
could have negotiated at an earlier stage.

Outsiders’
criticisms should only be offered with great care. But it says here that Tourre’s
spanking by the SEC is inevitable – so the sooner he bends over, the better.

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I’m about to be off for
several weeks, for that nearly-sacred ritual of summer holiday, so beloved in
Europe and observed with enthusiasm.

Predictions of the
unexpected that might arise while I’m gone are impossible, of course: human
mis-handling of complex events ranging from BP’s Deepwater Horizon to the Gaza
blockade to the quality of World Cup officiating show that timing pays no
respect to environmental disasters or tribal violence or even soccer’s off-side
rule.

But reasonable
expectations are that life may be calm for a while at least in the space that
is watched over here.

That’s because:

The world of
financial information and public accountancy was left untouched either by the
Dodd-Frank regulatory legislation now clanking toward passage through the U.S.
Congress, or by the Supreme Court’s ruling on the constitutionality of the
Sarbanes-Oxley law (here)

Invited to
inaction, then, rather than to further public mischief-making, American legislators
are now off for the summer to abuse their subordinates or their constituents or
their expense accounts.

Summer is not
typically the time for the eruption of financial scandal, which is rather
pressured into public view by the stresses of year-end reporting and the
eventual and unavoidable escalation and collapse of Ponzi-style machinations.

Instead, the next generation
of white-collar financial criminals are beavering away, beneath the screens of
visibility, always and ever searching out the exploitable weaknesses in the
world’s fragile systems of corporate governance and reporting.

So, while it is no
time for naïveté or diminished diligence, it may justifiably be time for a
little pause. The challenges of this fall’s new season of discontent will
arrive soon enough – so enjoy the summer while we can.

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June 30, 2010

On this last Monday
there were two non-events, both with heavy political overtones:

First was the
announced resignation of Jean-Pierre Escalettes, president of the French soccer
federation, after Les Bleus’
disgraceful crash out of the first round of the World Cup with two losses and a
draw.

Second, by a
five-four vote (here), the United States Supreme Court upheld all significant aspects
the Sarbanes-Oxley law of 2002 and the structure and operation of the Public
Company Accounting Oversight Board, save only for the means of removal of PCAOB
members.

There was always
something strained and artificial about the constitutional attack mounted by a
dinky accounting firm and an anti-Sarbox advocacy organ, raising points of
eye-crossing abstraction about the scope of presidential power to appoint and
remove subordinate officials.

So perhaps not
surprisingly, the Court’s constipated decision is in kind – leaving entirely in
place the law, the agency and its members, and satisfying nobody except court
scholars perched in the highest of ivory towers.

Because, for all
the anticipatory sound and fury --

There is this much disruption of the PCAOB’s business: None.

There
is this much need for legislative re-visiting of Sarbanes-Oxley: None

There
is this much likelihood that, with Congress on its way to summer recess and
mid-term election season around the corner of the calendar, there is any political
appetite to take up the multiple short-comings in the present scheme for the
regulation of the delivery of accountancy services to public companies: None.

For completeness,
however, although the nature of the status
quo has been righteously endorsed as robust, across the spectrum of the
satisfied – from the Sarbanes-Oxley authors themselves (here) to the lobbying arm of the large accounting firms (here) to the head of the increasingly marginalized AICPA (here), to the SEC chairman herself (here) –

Eight
years and billions of dollars down the Sarbox drain, the amount of demonstrably
beneficial deterrent effect on the global financial crisis and the performance
of the principal actors: None.

The
extent to which the cries for revisions in the PCAOB’s remit or ability to act
effectively in relation to the global market for useful and valuable audited
financial information (see, e.g., my
friends Francine McKenna and David Albrecht) have any chance of achieving results:
None.

The
probability that rational heads will constructively address the existential
crisis facing the survivability of the Big Four’s franchise of
privately-provided assurance to global-scale companies, ahead of the
catastrophic collapse of their business model: None.

Scholars of the
Supreme Court’s deliberations will debate endlessly the nuances of its
powder-puff result. Meanwhile the conversations amongst the Court’s majority wing can be re-constructed thus:

“We
can’t let this law stand. When the Constitution was written, independent
auditors hadn’t even been invented. This is not the crystalline path of our
gun-control logic (here),
from muskets in the militia to Uzis in Starbucks.”

“No,
but if we trash the whole statute, just think of what Chris Dodd and Barney
Frank might legislate in its place, that we might just have to live with.”

“Right.
Scary. And our Wall Street friends are living just fine with an agency that is
toothless and clueless.”

“So
if we do as little as possible, it may not resemble intellectually honest conservative
orthodoxy, but it might just sell as restrained and reasonable.”

“You’ve
got my vote, Chief. But only because we can’t bring back the guillotine.”

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May 23, 2010

Local news item: “Last night the high school
drama club played Shakespeare.Shakespeare
lost.”

Last week, SEC
Chairman Mary Schapiro played the 2010 annual conference of the chartered
financial analysts. Her speech is here.

Credibility lost.

Her ambitious list
of messages included a major tilt at four “myths” about the SEC’s lukewarm
attitude toward GAAP/IFRS convergence and globally merged accounting standards.

In protesting that
“you can’t always believe what you hear,” Schapiro’s pushback suffers the
inductive fallacy that opposition to your critics is not the same as proof of
your own position.

Whether or not the
agency’s own “commitment to international standards has flagged,” Schapiro either
could not face – or is still denying – the implacable international antagonisms
to convergence that her agency lacks the capacity to resolve.

There is, indeed,
no more eloquent concession of the “convergence gap” than Schapiro’s own
admission that “US GAAP and IFRS are currently not converged in a number of key
areas,” including “the accounting for financial assets (the very types of
securities at the center of the financial crisis), revenue recognition,
consolidation principles, and leases.”

Any other problems,
Madame Chairman? These on her list are so comprehensively grave that they will keep the international
standards standoff alive until the end of time.

It’s not necessary
to believe Schapiro to be as malign as Shakespeare’s Queen Gertrude, or to fault the bona fides of her commitment to the
“fundamental principle” of “comprehensive and neutral accounting standards.”
Because on the prospect of core-level GAPP/IFRS convergence, she is committed as
were the pre-Copernican astronomers to the “fundamental principle” of an
earth-centric solar system.

It’s just that
while good faith is fine, eventually it must yield to reality.

In assessing the
feckless attitude of America’s chief securities regulator, it helps to keep at
hand a glossary of trans-Atlantic euphemism. That is:

·When a
Frenchman says, “We need to be pragmatic,” what he means is, “Agree to do it
our way – or there’s no deal.”

·When an
Italian says, “You don’t understand how things are done here,” the unspoken
message is, “You have no chance – cut your losses and head for home.”

·And
when the typical balls-out American attitude gives way to Schapiro’s concession
to “understand the importance of
process to a successful conclusion (her emphasis, not mine), it means “We know
we’re screwed for now, so we’ll kick the can down the
road and try to sell it as success.”

The targets for Schapiro’s
spin were not clear, as she advanced the assertion that discussion on
accounting principles “is often limited to specialized journals and a handful
of websites for the kind of people that can tell a repo 105 from a 401(k).”

As if her pimping
would be seductive. Weighing in from his base in Minnesota, academic blogger
Dave Albrecht (here) made it clear that he did not just fall off the turnip
truck, with a trenchant Twitter message that the intelligence level of Schapiro's constituents other than the mainstream brown-noses is
entitled to more respect: “Ridiculous comments, sad that some might believe
her.”

Also counting
against Schapiro’s credibility is that, despite building her speech on the
three obvious pegs of the SEC’s mission, initiatives and priorities, she gave
not a single reference to a most basic issue – the continued viability of the
global assurance function.

Anyone still
thinking that the life-threatened auditors have “had a good crisis” over the
last three years (here) has not spent recent time around the courthouses – the
latest bullets added to the Big Four firms’ deadly game of Russian roulette being
Ernst & Young’s inclusion in the Lehman Brothers litigations (here) and the two-billion dollar claim against PwC by the winding-up board of Iceland’s Glitnir Bank
(here).

On the very day of
Schapiro’s speech, with its bare one-phrase reference to her “overseeing … the
PCAOB,” that agency published a list of some 400 non-US companies whose auditors
could not be inspected because of obstacles under their home-countries’ laws
(here).

The PCAOB claims to
be “currently prevented” from its mission – as if the issues of non-US
confidentiality, data protection and privilege have not been readily knowable
since before Sarbanes/Oxley birthed the agency birth back in 2002.

A good index of
global-scale companies, whose audits are out of reach of the PCAOB, could be
built from that list: a quick sample of household names from around Europe
includes AB InBev, Nokia, Total, AXA, Daimler, Deutsch Bank, SAP, Ryanair,
Luxottica, ArcelorMittal, ING, Ericcson, ABB, Credit Suisse, Royal Bank of
Scotland, WPP, BP, AstraZeneca, Pearson and Unilever.

To be really transparent,
the internationally toothless PCAOB might publish its short list of those
companies for whom audit inspection did not present obstacles (a sub-set whose total market capitalization would not
make a flyspeck on the windshield of the world’s economic engine). Or, perhaps,
the far longer list of those companies for whom auditor inspections have not
even been attempted.

Schapiro claimed that
“investors – from anywhere across the globe – come under the SEC’s umbrella of
protection. ”

She might more
candidly confess to all investors, “bring your own foul weather gear – you’re on
your own.”

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May 03, 2010

A reader has just
asked how, under a cascade of falling knives, Goldman Sachs might shelter
itself?

Media coverage of
last Thursday’s Senate hearings tip-toed around the use by Subcommittee on
Investigations Chairman Carl Levin (D.-Mich.) of the internal nomenclature of
the “sh*tty deals,” like pedestrians in sandals on my dog-infested Paris
street.

The odor of the
entire sordid proceedings was unrelieved by the insistence of more punctilious
editors on asterisks and euphemisms, nor was the dignity of America’s upper
legislative chamber improved.

Goldman confronts a
quartet of threats, of which only the latter two will be serious:

The Senate’s orgy
of finger-pointing is now old news, supplanted by the BP oil spill, the Times
Square car bomb and the British elections.

The eventual financial
services legislation to emerge from the Congress will be pernicious and
misguided, but no less survivable by Goldman than by any other banks.

The SEC’s suit over
the subprime-mortgage-backed product designed and sold at the behest of hedge
fund manager John Paulson, and the potentially broader and more crippling
criminal investigation by Justice, will resolve in due course.

And, ultimately,
there will be a franchise value effect of the verdict to be rendered by the
court of public opinion.

In reaction to the
reader’s query, Goldman might well re-deploy the energy and creativity of its
SEC co-defendant, the young hot-shot Fabrice Tourre. The self-styled “fabulous
Fab” is now evidently side-lined in its London office – under the classically
sound tactical decision to keep him on board rather than throw him overboard
into the waiting jaws of the sharks of law enforcement.

That is, Tourre as
a pitchfork veteran around the Goldman sh*t-pile should see the threats to
Goldman’s franchise value as both a challenge to new product development and an
opportunity to generate both revenue and rehabilitation.

Namely:

The street already
sponsors talk of a settlement between Goldman and the SEC, which will affect
the company’s now-depressed stock price. But why would a simple office pool on
the outcome be the only bet? Rather than pursue the mundane approach of
speculation in either GS itself or its vanilla options, a creative derivatives
engineer would build a whole suite of investment products tied to the timing
and cost of the resolution.

The simplest
tradable derivative would be on the straight-dollar over/under of the SEC
settlement – the likelihood of a litigated defense victory being as much an
unimaginable outlier as, say, the industry’s prior assessment of the collapse
of LTCM, Bear Stearns or Lehman Brothers.

Those interested in
handicapping the competing litigation capabilities of the SEC and Goldman’s
counsel could test their assessments in the marketplace. Also, Goldman is said
to be facing potential legal expenses of up to $100 million – certainly enough
to set up a special fund whose performance would be tied to the cubic volume of
the court filings.

Those believing
that Goldman is Satan reincarnate rather than the Lord’s messenger could take
faith-based bear positions on the outcome, while those cynics who profess
skepticism that politics underlie the SEC’s case would do the opposite.

As for the more
threatening criminal proceedings, opportunities arise to speculate on the
stability of Goldman’s reputational capital. With the Fab’s proven ability to
spin gold out of subprime sh*t, it would be child’s play to devise a
“reputational index” that could be traded long or short – perhaps tied to the
firm’s movement in league tables or deal flow.

Subsidiary products
could handicap the odds on the most likely individual candidates to be thrown
under the litigation bus -- including (probably in inverse order) CEO Lloyd
Blankfein, COO Gary Cohn, CFO David Viniar, and the soon-to-be dispensable Mr.
Tourre himself.

What is critical
for Goldman, of course, is to capture for itself not only the hedging
opportunities but also the vigorish on all this activity, rather than leave
anything at the table for the competition.

Having the inside
track on the timing of litigation developments, costs and strategies would seem
to require scrupulous care not to be seen as arbitraging its privileged
position or trading under conflicting interests. But if its claim to sponsor’s
neutrality in the original CDO deal is given credence, Goldman should have
nothing to worry about.

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April 26, 2010

Whether and how to
regulate the financial institutions’ creation and trading of exotic
derivatives? Who should be enabled, or barred? Are there some so complex or
toxic they should be banned? And critically – who thinks that Senator Dodd and
his cohorts in the US Congress can sort it out?

I go back to the lessons
on the farms of my youth.

It was an unvarying
ritual: every evening, when the chores were done, my grandparents would convene
to listen to the market reports, over the bakelite Philco that had pride of
place on the kitchen table.

It was especially
important, when their feeder calves were ready for market, to have the daily
cattle prices from the stockyards of Chicago and Omaha and Sioux City – because
their timing had to strike a delicate balance. A driver and his truck had to be
engaged. But commit to ship too early, and the animals would be under-prepared.
Yet the risk of delay, for possible price moves, meant the possibility of being
wrong, plus the dual impacts of extra feed costs and a loss of quality due to
over-finishing.

By the time I was
old enough to spell “cattle futures,” my astute grandfather was, through his
commodities broker, hedging the on-the-hoof financial exposures that were out fattening
in his feedlot – mitigating the random forces not only of market volatility but
also pasturage and herd diseases and freight costs and all the malign hazards
of a family farm.

What of his
counter-parties? On the other side of his trades may have been Iowa Beef or
McDonalds, or more likely a pure speculator – the zero-sum nature of
derivatives trading made no difference to him.

The derivatives
markets have known forever that at the end of the chain, some end user converts
pork bellies to bacon and Brent crude to aviation fuel and even some of the
gold into jewelry. But it doesn’t care. Grandpa’s fatted calves wound up as
steaks and roasts and hamburgers, but trading regimes have never limited
derivatives participation to packing houses and restaurant chains. Rather, a
multitude of positions have evolved by way of options and futures, longs and
shorts, insurance and hedges.

And it’s equally
true throughout the financial markets, where product innovation is one of
capitalism’s articles of faith. Equity ownership in a single company begat the
assembly of portfolios -- in turn democratized into managed mutual funds. From
which it was no long step to the massively popular index funds, and thence to
tradeable positions on the indices themselves.

Wagers of all
varieties became available, on the movement of the S&P 500 or the FTSE 100,
or sub-indices sliced and diced to the customized needs of the players big
enough to ask. And the model is not only very far removed from actual ownership
in the original underlying stocks – it bears considerable resemblance to the
concoction by Goldman Sachs of a shortable product only distantly related to
the houses temporarily occupied, before foreclosure, by the original subprime
borrowers.

Society has
similarly concluded that the only requirement to sit at a gaming table is a
stack of chips. The house will happily offer a chance to play, and to accept
the money of the unsuccessful, without requiring proof of aptitude, or a
working knowledge of the odds of filling an inside straight or bringing home an
exotic roll of the dice.

Such dark pools of
manipulated information as dog tracks and jai
alai are allowed, for the entertainment of the tourists and the fleecing of
the credulous. And local governments themselves peddle lottery tickets to the
masses, against odds that would make a card shark blush.

In his hard-shell
Methodism, Grandpa would never have set foot in a casino – he’d have scorned
the frivolity and, more to the point, would have shunned an activity so far out
of his capacity to comprehend and manage.

But allowed to live
under his own principles, he’d have given taciturn tolerance to those engaged
in legal if obtuse gambles.

Raised on the
working end of a plowline and a pitchfork, and through a life driving a tractor
and pitching bales of hay, Grandpa cultivated understatement and restraint -- along
with an annual abundance of corn, beans and beef -- and never used two words
when one sufficed.

His snort of
derision would have been a wordless editorial -- “fool, to play a game you don’t
understand.” But his own hard work and intelligent self-reliance would have
respected the inevitability of creative innovation.

Rather than let a
bunch of posturing politicians dictate or constrain his investment choices,
he’d have let the markets decide which financial products proved their value,
measured his risks, and taken his own advantage.

And so should
we.

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April 19, 2010

As the great
baseball umpire Bill Klem said, about whether a pitch was a ball or a strike:

“It
ain’t nothin’ ‘til I call it.”

Which, as a lesson
in political science, is being taken to heart by only some of those holding
forth on the April 16 charges of fraud lodged by the Securities and Exchange
Commission against Goldman Sachs and one of its employees (here), alleging
misstatements and omissions in the structure and marketing of a synthetic
collateralized debt obligation tied to residential mortgage-backed securities.

The SEC’s
enforcement director, Robert Khuzami, dealt a high fastball -- avoiding
complexity in packaging his advocacy for public soundbite-scaled consumption
(here):

“The
product was new and complex but the deception and conflicts are old and
simple.”

Goldman itself
played its defensive position the same way, but to different effect (here). Its terse
one-liner fouled off the pitch: “We are disappointed that the SEC would bring
this action related to a single transaction in the face of an extensive record
which establishes that the accusations are unfounded in law and fact.”

Give Goldman points
for a sense of reality, recognizing both that the judicial process will be
unaffected by public posturing, and that the court of public opinion itself
will not be in a mood for hand-wringing.

For it remains a
mystery what inspires any claim to credibility by the typical spinners of
over-played corporate protestations, when initial impassioned pleas of
innocence give their inevitable way to plea bargains and outsized settlements
to “put it all behind.”

Meanwhile, the
purple clouds of “I told you so” commentary from the bloggerati are as noxious as the volcanic spews from Iceland, and
should only be dispersed as rapidly into inconsequence.

Not least, the
self-righteous are – as customary – conflating an initial law enforcement
complaint with an adjudicated conclusion. Consider:

·Much as
public opinion had convicted O.J. Simpson of his wife’s murder, before his
trial, the jury found otherwise – and he remained at large until the outbreak
of his predictable recidivism.

·It was
financial and structural weakness that felled Arthur Andersen, not its
indictment – remembering that procedural flaws in its conviction led to the
Supreme Court’s reversal, but with no element of vindication or rehabilitation.

·Even
the now-jailed Bernie Madoff was presumed innocent (although charged) until the
entry of his guilty plea, and entitled to bail and at least a measure of his
liberty.

Respect for due
process requires a measured recognition that the SEC case is at the top of the
first inning – though there may well be further cases, additional claimants and
private claims as well (see Kevin LaCroix’s always helpful D&O Diary).

But Charlie Green
also has it right, at Trust Matters. That is, if as Charlie suggests, the SEC’s
case “resonates easily with Main Street as also being unethical,” and as corrosive
to credibility, motives and trust, then the capital markets community will hold
Goldman accountable for the state of its franchise in ways that the judicial
process can never address.

A final constituency
is yet to be heard from, about we should worry. Eight years ago, when the
collapse of Enron was trailed by WorldCom, a stampeded Congress inflicted
Sarbanes/Oxley and its massive demonstration of the law of unintended
consequences.

Given its head, a
legislature bent on retribution against the financial services sector is
capable of twinning up the bankruptcy examiner’s report on Lehman Brothers (see
here) with the SEC’s complaint against Goldman.

In which case,
anxiety should run very high.

Because the result,
in Bill Klem’s terms, will most likely be a wild pitch.

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There was at least one
bit of good news implicit in the otherwise-dispiriting April 7 alert from the
Public Company Accounting Oversight Board, “Auditor Considerations of
Significant Unusual Transactions” (here).

Which is that,
although the large accounting firms may well not survive the wounds of their
own exposures (see Francine McKenna’s March 23 compilation), they
are in no present danger from their American regulator.

It is not clear, because
neither auditors nor their overseers are recognized for their humor or their irony,
whether it is cause for laughter, or perhaps tears, that the functionaries in Washington have so little respect for the profession, as
to believe it useful to “remind auditors of public companies about …the risk
…posed by significant unusual transactions.”

Behind the text of
the alert – which offers not a single example or illustration to suggest that
the PCAOB itself has a clue – is another “reminder,” for anyone still thinking that
government-provided audit guidance might supplant private assurance, in the
event of Big Four disintegration and collapse: The PCAOB shows itself ill equipped
to lead from Point A to Point B.

It was never
credible, that the very government that imposes on its citizens the Postal
Service, Fannie Mae and the IRS should be capable of delivering assurance of any
value on the complexity of global-scale corporate financial statements.

The PCAOB’s insult
to intelligence now makes that crystal clear. The best advice on offer – eight
years after the Sarbanes/Oxley law begat the PCAOB and a regulatory regime for
which the world was not holding its breath – is the stunningly obvious
proclamation (page 2) that “although the economic conditions have changed since
December 2008, the risk factors, including the risks of unusual transactions,
that existed in December 2008 continue to exist today….”

Whew – thanks for
that insight, for sure.

Justification for an
alert is said to be the highlighting of “new, emerging, or otherwise noteworthy
circumstances.” By its own terms the alert fails on the first two, so the
question is what might be “noteworthy” (page 2) about “compiling selected,
relevant requirements from existing PCAOB standards … into one document.”

Does the PCAOB
believe that audit professionals cannot read their basic literature, without
their attention failing or their lips getting tired?

With expectations
that low, where do they expect the professional wisdom and judgment be found,
in an audit engagement team out on the job, to comprehend the subtleties of
whether “the form of transactions is overly
complex” (page 5) or if “management is placing more emphasis on the need for a particular accounting treatment
than on the underlying economics of the transaction”? (page 6, emphasis
added)

If so, the next expected
step in the dumbing-down of regulation will be “GAAS for Twitter” – auditing such
tough subjects as related parties and special-purpose-entities and complex
derivatives, 140 characters at a time. Not, we should fear, a recipe for
enhancing the value of the audit process.

Further, one
seriously nasty hostage to politics in the PCAOB release is the admonition to
engagement teams to “consult with individuals having appropriate levels of
knowledge, competence, and judgment regarding significant unusual
transactions.”

Not only does that
finger-waving come with the warning that “the engagement quality reviewer
cannot provide concurring approval of issuance if he or she is aware of a
significant engagement deficiency, including those regarding significant
unusual transactions.”

More importantly,
as noted here, the PCAOB’s minders at the SEC in December besmirched an entire senior consultation
hierarchy at Ernst & Young, announcing enforcement sanctions against the
firm and six of its partners over the quality and risk review process followed
for Bally Total Fitness – a shot
across the bow of professional quality consultation that cannot be encouraging
to the kind of consultative practices now urged by the PCAOB.

Regulatory
“reminders” at the PCAOB’s elementary level may be an inevitable nuisance in a
nanny-state environment of excessive bureaucratic intrusion, but their real
impact will be a further degrading of the agency’s own stature and credibility.

At this rate, the PCAOB’s
next release will be a “reminder” that debits must still equal credits.

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